A Catering Theory of Earnings Guidance: Empirical Evidence and Stock Market Implications

Abstract

We propose and test a catering theory of earnings guidance. As predicted by our model, managers cater to reference point dependent investor preferences by issuing excessively optimistic earnings forecasts if their investors have experienced poor stock returns. Moreover, earnings guidance is most biased when managers strongly discount future outcomes, when the stock's payoff uncertainty is high, and when managers face low costs for issuing inaccurate forecasts. Catering via earnings guidance succeeds in moving stock market prices and induces mispricing which is corrected around the corresponding final earnings announcement.

Keywords: Management Guidance, Catering, Capital Gains Overhang, Stock Mispricing

JEL Classification: G14, G30, M41